I Savings Bonds

I Savings Bonds are government bonds that pay both a fixed interest rate and an adjustable interest rate that corresponds with the U.S. Consumer Price Index (CPI).

The fixed rate of return is determined when the bond is purchased. The variable rate is calculated semiannually based on the inflation rate.

How It Works

The variable rate on an I Savings Bond is determined using the Consumer Price Index for Urban Consumers (CPI-U) for the months of May and November of each year. Fixed rates and semiannual inflation rates are combined to determine composite earnings rates. An I Bond’s composite earnings rate changes every six months after its issue date.

Fixed and variable rates for I Savings Bonds issued over the last 10 years are posted on the Treasury Direct Web site (www.treasurydirect.gov).

What if the value of the CPI is falling?

This happened in the most recent pricing of these bonds. In May of 2009, the fixed rate for newly issued bonds was 0.10% and the semi-annual inflation rate was –2.78%. The formula for determining the interest rate is as follows:

This equation led to a composite rate of –5.74%. The Treasury will not allow composite rates to be negative, so the interest rate was set at 0%.

I Savings Bonds have 30-year maturities; however, you can redeem them at any time after a 12-month minimum holding period from the date of purchase. These bonds increase in value monthly and all of the interest is paid when you redeem the bond. If you redeem a bond before it is five years old, you will forfeit the most recent three months’ interest.

I Savings Bonds are sold at face value (meaning you pay $50 for a $50 I Savings Bond). These bonds can be bought electronically in any dollar amount over $25. Paper I Bonds are sold in the following denominations:

$50, $75, $100, $200, $500, $1,000, and $5,000.

Different From EE Bonds

The government also offers EE Savings Bonds, which are similar to the I Savings Bonds but with a few differences.

EE Bonds have fixed rates that are adjusted each May 1 and November 1, with each new rate effective for all bonds issued in the six months following the adjustment.

Like I Bonds, these savings bonds are exempt from state and local taxes and if the bonds are used to pay qualifying college expenses, they are exempt from federal taxes as well.

Unlike I Bonds, the U.S. Treasury guarantees that, at a minimum, an EE Bond will double its value after 20 years and will continue to earn the fixed rate unless a new rate or rate structure is announced.

If an EE Bond does not double in value as the result of applying the fixed rate for 20 years, the U.S. Treasury will make a one-time adjustment after 20 years to make up the difference. EE bonds continue to earn interest for 30 years.

To learn more about EE Bonds, see the Offbeat Offerings column that appeared in the November 2007 AAII Journal (available at AAII.com).

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How to Invest

You can purchase I Savings Bonds directly from the government using the Treasury Direct Web site. You can set up automatic purchases of the bonds in $25 increments.

You can also purchase I Bonds via some banks and other financial institutions. The purchase limit for both paper and electronic I Bonds is $5,000 per calendar year.

I Savings Bonds are non-transferrable and cannot be redeemed within 12 months of purchase. If you redeem the bonds within five years of purchase, you will forfeit three months of interest payments.

You can redeem bonds via Treasury Direct or through the financial institution where you originally purchased the bonds.

Investor Suitability

I Savings Bonds are for investors wanting a safe place to put money. The interest rates are low, but you are guaranteed a fixed plus variable rate of return. If inflation is high, your interest rate will increase, making these bonds a good choice for investors looking to protect themselves from inflation.

Tax Implications

Any interest earned on I Savings Bonds is subject to federal income tax, which can be deferred until redemption, final maturity or you sell the bond. Savings bonds are subject to estate, inheritance, gift, or other excise taxes, whether federal or state.

Like EE Bonds, special tax benefits are available to qualified owners of I Bonds under the Education Savings Bond Program. Investors using the proceeds of the I Bond for qualified higher education expenses can exclude all or part of interest earned from their income for federal tax reporting. Only certain types of expenses qualify, so be sure to fully understand the program before purchasing the bonds.

The Pros

Guaranteed by the Government

I Savings Bonds are fully backed and guaranteed by the U.S. government, making them a virtually safe investment.

Tax Benefits

I Savings Bonds are exempt from state and local income taxes, and if used for college tuition, are exempt from federal income taxes as well.

Inflation Protection

I Bonds have a fixed rate of return combined with a variable rate based on the CPI. As inflation rises (and, in consequence, the value of the CPI), the interest rate on the I Bond will rise.

The Cons

Early Redemption Consequences

You cannot redeem an I Bond within 12 months of purchase and if you redeem it within five years of purchase, you will forfeit some interest payments.

Low Rates

As of May 2009, newly issued I Bonds had a fixed rate of only 0.10%. Combine this with a negative inflation rate, and the bonds issued were earning 0% for the first six-month holding period. During times of falling inflation, you may not earn any interest on the bond.

Additional Information

TreasuryDirect is sponsored by the U.S. Department of the Treasury’s Bureau of the Public Debt. TreasuryDirect is a financial service Web site that allows investors to purchase and redeem securities directly from the U.S. Treasury Department in paperless, electronic form.

The site also offers product information and research tools for a variety of Treasury securities, including a Savings Bond Calculator that allows you to find out what your bonds are currently worth.